Emerging agricultural trade issues:
Challenges for EU and US policies

Tassos Haniotis*

University of Georgia
The Seventeenth J.W. Fanning Lecture
November 28, 2001

1. Introduction

During the days preceding the recent launch of the new WTO round in Doha, Qatar, the European Union (EU), or more accurately its Common Agricultural Policy (CAP), was presented at times as the stumbling block of progress in trade liberalisation in the area of agriculture. The EU (or better some of its members, but for WTO procedures requiring unanimity the result is the same) was seen as refusing to accept the phasing out of export subsidies and wanting to link advances in trade liberalisation to vague concepts of non-trade concerns. Oh, yes – even bananas was briefly back in the picture!

This depiction of the EU as the stumbling block of agricultural trade liberalisation awoke memories of my graduate years in this University in the 1980s, and especially during the latter part of the decade. At that time, the previous assertion about the role of the CAP received strong support from facts. And the story that those of us coming from the EU had to defend, with limited success I must admit, was a defensive one. We had no problem focusing on the past in order to explain the origins of the CAP, but its future was less certain.

Yet the story I intend to describe to you today is not of old memories, but of recent facts. And a close look into these facts and the dynamic development of the CAP during the last decade provide indications of a policy that is changing in a direction that deserves more attention and may I add more credit.

As a good graduate of this University (I hope) I will try to put in practice the above claim by doing what an applied economist is best trained to do. That is, to turn this claim into the working hypothesis of this lecture and leave the proof to your judgement at the end.

In what will follow I will claim that the process of reform of the Common Agricultural Policy initiated almost ten years ago has brought the European Union much closer that is generally accepted or expected to fulfilling the future requirements of a market-oriented agricultural policy.

On the contrary, US agricultural policies that only just five years ago seemed to set the stage, and for many the standard of an exemplary structure of agricultural policy with respect to market orientation, are developing in the opposite direction. Instead of looking forward, they have shifted into the re-introduction of policy tools that just a few years ago had to be abandoned, considered as having failed to meet their objectives.

But despite this shift in opposite directions in terms of policy measures, the EU and the US have moved in similar direction in at least one area, that of the increasing recognition of a wider role of agricultural policy for the rural economy.

2. On agricultural policies today

The fact that the above rather strong assertions on the development of EU and US agricultural policies are not widely shared should not come as a surprise. In our times, one would rarely focus on the CAP, or any agricultural policy for that matter. Our societies are predominantly responding to other priorities, be it priorities whose agenda we determine, or priorities that reflect agendas imposed upon us.

Of course, from time to time an issue related to agriculture will draw attention for its international dimension. Increasingly in Europe, such an issue would tend to be related to real or perceived threats that agricultural practices are considered to imply for public health. Sometimes, such issues would potentially impact on trade as a result of applications of a technology pertinent to agriculture (from growth hormones to biotechnology). More rarely, a more traditional trade policy friction will also grasp the headlines – bananas being only one, albeit infamous, example.

But in general, our societies, and I am speaking here about societies of the developed world, have the tendency to take food, and the processes that produce it, for granted. The great majority on this planet does not have the luxury to do so; but we do. This has consequences for our priorities related to the production of food and for the manner by which we deal with them.

Yet in the EU we continue to consider that agriculture is different from any other sector and will continue to do so, although perceptions about why agriculture is different have evolved. Let me schematically refer to these as old realities and new realities facing agriculture.

The old realities were based on the belief that agriculture is fundamentally different from other economic sectors because the interaction of demand and supply affects agricultural markets in a unique way. Demand for food is continuous, as its availability on a daily basis is indispensable. Total demand for food is also income and price inelastic. The supply of food, on the other hand, is discontinuous, and is characterised by some really unique features: land and farm labour fixed in time and space, weather induced uncertainties, biological cycles in production that render short-term adjustments to shifts in demand impossible, unexpected supply shocks.
The new realities are quite different. On the demand side, the food sector is characterised by an increased emphasis on food safety and precaution. Risks and benefits in the sector are assessed and weighed with almost zero tolerance by a large part of the population. Environmental concerns are equally important, and a negative image of agriculture’s contribution prevails. Finally, the methods of production receive increased attention, as is widely demonstrated by animal welfare considerations.

On the supply side agriculture faces increased production costs from demand-driven pressures. It also faces an uncertain long-term horizon, with doubts not so much about the implemented policy reforms, but about what is perceived as an endless reform process. Finally, direct interaction between producers and consumers of agricultural produce becomes more difficult with increased food chain bottlenecks.

Old or new, these realities generate price and income instability, and requests for policy measures to deal with it. Whereby the old realities led to what we can call the “old CAP” (up to 1992), the new realities led to the “new CAP”, best represented by the Agenda 2000 reform. The latter has resulted in a set of policy objectives that constitute the basis for review of the extent to which our existing policy tools fulfil their tasks. But they also provide a good reference that allows one to judge the true extent of similarities between EU and US policy objectives. These policy objectives of the “new CAP” are:

•    a competitive agricultural sector, which can gradually face up to world markets without being over-subsidised;
•    production methods which are sound and environmentally friendly, able to supply quality products that the public wants;
•    diversity in the forms of agriculture, which maintain visual amenities and support rural communities;
•    simplicity in agricultural policy, and sharing of responsibilities between the European Commission and EU member-states;
•    justification of support through the provision of services that the public expects farmers to provide.

3. EU agriculture in some simple facts and figures

Before moving further, let me briefly try to shed some light on basic facts and figures of agriculture in the EU. Today the EU ranks close behind the United States as the second largest agricultural exporter in the world. This position is not due to the bulk of our agricultural commodities but to the value added of our food products, as the development of EU-US agricultural trade balance amply demonstrates (Graphs 1-3).

But at the same time, the EU ranks by far as the largest agricultural importer with close to 60 % of our imports coming from the developing world. And despite all the unfounded and misplaced criticism that alleges the EU being a “fortress”, our positive contribution to growth in the developing world is amply evident by a simple fact. The EU alone imports more agricultural products from the developing world than the US, Japan, Canada, Australia, and New Zealand taken together.
 
But ten years ago, when the CAP was about to face its first major reform in terms of its orientation, things were different. The 1992 reform resulted from the accumulation of a series of problems that led to domestic and international criticisms of the CAP as a policy that was too expensive and too ineffective. The image of EU agriculture was one of mountains of grain or butter and lakes of wine – not exactly an idyllic image of the EU countryside.

At that time, market measures related to support of agricultural products (public intervention, export subsidies and the like) accounted for 91 % of the agricultural budget of the EU (Graph 4). Last year marked the first year of the implementation of Agenda 2000, the second major reform of the CAP within a less than decade, agreed in 1999. But by now, product support in the EU has declined to 21 % of its agricultural budget.

The EU budget still provides significant support to EU agriculture. But increasingly it does so in the form of support to producers. This support currently accounts for 63 % of the EU agricultural budget, and is expected to reach 68% by 2006. For comparison, direct support accounted for 9 % of the agricultural budget in 1992.

And although international comparisons are often prone to oversimplification, I should dare to make one. In 1992, EU domestic support price for wheat was 47% above the level of world market, and public intervention had to sustain this level. Today the EU wheat market price is above the world market level and no public intervention or even export subsidies are required (Graph 5).

4. The policy behind the figures

Of course the previously mentioned caveat of international comparisons should be kept in mind. The exchange rate, one in many external factors that influence agriculture, has played a certain role in improving the competitive position of EU agricultural products.

But there should be no doubt about the fact that the most important changes in the position of EU agriculture in an international context were policy-driven.

In both major reforms of the Common Agricultural Policy within less than a decade, the EU moved in the same direction, making a shift towards a more targeted and less distorting agricultural and rural policy. It was this significant shift in EU policy away from product support and supply control towards producer support that allowed EU agriculture to reap the benefits of favourable external developments, and to minimise the impact of negative ones.

The experience to date of the shift from price support to direct payments in the reformed sectors has been globally positive. Market balances in particular have significantly improved and agricultural incomes have developed generally more favourably than their previous trend.

Part of the support burden has of course shifted from consumers to taxpayers, but budget expenditure has become more stable and predictable (the volume of direct payments being set) and support to farmers has become more transparent.

Let me briefly describe the impact of this direction of policy change in the international context by returning to the evolution of the EU cereal policy during the last decade. During this period, EU farmers saw the prices they received for their wheat decline by a cumulative 35% during the last ten years, from 170 € per metric tonne in 1992 to 116 € per metric tonne in 2000 (Graph 6). The income decline corresponding to this price drop was compensated by the introduction of a system of direct aid per hectare (roughly equivalent to the drop of price).

But the decline in the intervention price, although neutral in farm income terms, was very positive in market terms. It re-established intervention into its appropriate role - that of a safety net, not an umbrella protecting farmers from all price volatility.

What was the result of this policy? With lower domestic prices, domestic demand for EU wheat (and other cereals) reversed its previous downward trend, and instead increased by 40 % (Graph 7). In addition, EU cereal exports also became more competitive, and can thus be exported with lower subsidies, or recently with no export subsidies. Finally, lower feed costs resulted in lower prices for meat products (pork and poultry). As a consequence, the share of unsubsidised pork and poultry exports has increased impressively, representing today almost three quarters of their respective exports, up from less than a tenth before 1992 (Graph 8).

If the period of reform is taken as a whole (1992-2002), market support prices for cereals will have fallen by 45% and beef by 35%.
 
Lower trade-distorting market support, lower export subsidies, isn’t that what the implementation of the Uruguay Round Agreement on Agriculture is all about?

But what will the new WTO Round imply for agriculture?

5. What will the new WTO Round imply for EU Agriculture?

Let me first look at what it would imply for EU agriculture. The EU expects agricultural negotiations to strike a balance between fundamental trade reform (by reduction of both border protection and domestic and export support) and non-trade concerns. A future WTO agreement must lead to further agricultural trade liberalisation while at the same time allowing WTO partners to maintain a policy that respects and fulfils their domestic priorities. The long-term objective of creating a market-oriented agricultural trading system should also entail special treatment for developing countries.

In that respect, the result from Doha was very successful for the EU.

On market access, the Doha Declaration refers to negotiations aimed at substantial improvements, thus recognising the importance of further trade liberalisation. Maybe in contrast to the previous round, the fact that the EU aims itself at more market access is an increasing reflection of the fact that as a major exporter the EU intends to share in the expansion of world trade in agricultural products.

The EU will seek to obtain improvements in opportunities for its exporters, inter alia through greater clarity in the rules for the management of tariff rate quotas (TRQs), and the removal of other unjustified non-tariff barriers. The latter include the protection of geographical indications, to ensure that EU exports do not face unfair competition from deceiving practices such as the use of well-established EU denominations.

As major importer, and a partner sensitive to issues of the developing world, the EU also believes that developing countries should get special treatment. We already offer major preferences to imports from least developed countries. What is more important, we have already decided to import more in the future by opening our markets to all products but arms from the 49 poorest countries. And we expect and invite the rest of the developed world to show the same commitment.

But we are convinced that preferential treatment is the key. An across the board overall trade liberalisation would of course eliminate such preferences and penalise most developing beneficiary countries.

On export competition, the Doha text refers to the reduction of all forms of export subsidies. The qualification in the Declaration that nothing is meant to prejudge the outcome of the negotiations clarifies beyond doubt that there is no commitment now to negotiate the elimination of export subsidies.

Often reference is made only to export subsidies, with the accent placed on the fact that almost 85% of all agricultural export subsidies are attributed to the EU. There is nothing new or unexpected in this fact. It is a reflection of the structure of previous EU farm policies, incorporated in the EU commitments. In fact, the positive impact of CAP reform allowed us to meet easily these commitments.

Thus our export subsidies, under strict rules and disciplines, have declined significantly, and are expected to decline even further as a result of the latest CAP reform (even before a new WTO agreement comes into place). They now represent not more then 9 % of export values, as against 25 % decade ago. The Community is willing to continue to negotiate further reduction of export subsidies.

But this presupposes that all such support to exports is treated on a common footing. This means that the commitment to introduce disciplines on agricultural export credits (including the provision of food aid on concessional credit) must be respected. Other less transparent forms of export support, such as the operation of single desk exporters, will also need to be satisfactorily addressed.

On domestic support, the Declaration commits parties to negotiating reductions in trade distorting support. This fits with EU proposals for further cuts in the "amber box" whilst keeping the concepts of the "green" and "blue" boxes. This position does not rule out some updating of the blue and green boxes.

But it stresses the continuation of the present distinction of policies according to their degree of trade-distortion as the essential element in determining adherence to the desired move away from support linked to prices or products towards more transparent and non-trade distorting support policies.

6. US agricultural policy developments

Let me now turn on US agricultural policies, more specifically on the manner by which recent developments would impact on the US farm policy debate. Perhaps nothing best describes the evolution of EU and US agricultural policies in recent years than a comparison of their respective budgetary outlays for farm support (Graph 9).

Looking at commodity support alone, the EU has spent roughly $ 5 000 per farmer over the last five years, in support spread out to a series of farm commodities. In the same period, US commodity support per farmer has jumped from $ 2000 to almost $ 15 000 in just five years! How could this happen?

When the Uruguay Round Agreement on Agriculture (URAA) begun being implemented in 1995, US agriculture appeared to have achieved a major victory with respect to its long-term objectives and interests. Long forgotten were the reasons for which agriculture had stayed out of GATT rules in the first place (Section 22 of the US Agricultural Adjustment Act, that kept US agricultural policies excluded from international trade rules).

What mattered was the reality that in 1995, world market prices in major farm commodities were increasing, Congress was pushing for the Freedom to Farm concept and by 1996 prospects for US farm exports seemed as bright as ever. It was this situation that guaranteed strong support of the URAA by all mainstream groups representing agricultural interests (producers, commodity groups and agribusiness alike).

These were the years when trade was considered as the “ultimate safety net” for US farmers. After all, US agriculture is mainly an export-oriented agriculture, especially in bulk commodities. It is also one of the few areas of the US economy generating a trade surplus. Therefore, market access for US commodities is a high priority for the US, as is the abolition of any measure (e.g., export subsidies) that would directly impede the competitiveness of US exports.

However, market developments, especially the deterioration in world market prices (or for many experts, their return to normal levels) challenges US agricultural policies and the debate about the future Farm Bill in a way that was unimaginable even a few years ago.
Successive farm relief packages, starting in 1998 and becoming an annual ritual ever since have exhausted the budgetary savings expected under the FAIR Act ($ 13.4 billion, the driving force behind the introduction of fixed payments) in just three years.

Yet just as recently as 1997, the US did not expect to enter the new round of WTO negotiations on agriculture facing any problems with its domestic support commitment. In October 1997, an article of the Agricultural Outlook (a publication of USDA) looked into the US Aggregate Measure of Support (AMS), i.e. the part of US domestic support that fell under reduction commitments under the URAA. It concluded that it would fall to $2.4 billion by 1999 and $1.2 billion by 2000 (or at 12% and 6% of its respective commitments).

More importantly, these “exceptional” payments, the heavy use of the loan programme and the postponement of the dairy reform resulted in a completely different picture. Under the impact of these developments, things have changed drastically since 1997, and the US level of AMS is coming closer to its ceiling.
 
This situation seems to have influenced the current farm debate in such a way, as to render a continuation of the 1996 direction impossible. The relevant policy question in the US has become how to exhaust available budgetary outlays to support farmers. But the most likely answer to this question seems to be the re- introduction of some of the most trade distorting measures of domestic support. In essence, this is the result of a policy dilemma with significant political implications.  

In the US, the provision to farmers of payments in excess of what was foreseen and expected results in retaining land values in their current, artificially high levels. (In fact, if anything, it is land values that have been “de-coupled” from market developments in US agriculture). In addition, these high payments also generate production levels that are higher than what current market prices would generate, thus leading to further downward pressures on prices. The result is a continuing price crisis.

If Congress were to decide to limit the availability of emergency funds to US farmers, thus allowing some adjustment in production to take place (reverting to the forgotten “low prices are the best cure for low prices” dictum), then land values would have to give in. But land values represent almost three-quarters of the assets of the US farm sector. Their eventual decline will then result in a deterioration of the debt-to-asset ratio (the main indicator of the healthy financial situation of US farming), and lead to an inevitable debt crisis.

Both variants of the current US farm policy impasse are unpopular inherently (for totally understandable reasons) to US farm policy makers, and the alternative (a price spike driven either by supply or demand factors) is beyond the control of Congress. This possibility existed in 1998, when the perceived decline in US farm income was actually an adjustment to its normal level as a result of the return of world prices to their long-term trend, and thus the need for “relief” not evident. But successive relief packages have complicated things.
More so since experience form the post-1996 situation indicates that a demand-driven price recovery results in strong supply responses from major US competitors in the Southern Hemisphere, while a weather related price recovery always limits benefits to those producers who manage to salvage their own supply.

7. Non-trade concerns and their relevance for agricultural policy

Developments described above render the position of the EU in defending its agricultural policy easier than in the previous round. Clearly, most WTO parties disagree with the ability of the “two elephants” of WTO to support their domestic farm policies with significant budgetary outlays. But when the debate focuses on the consistency in the direction of policy reform, the correlation of words and facts tend to be much higher in the EU case than the US one.

But where the EU position finds a lesser degree of understanding is our insistence to incorporate non-trade concerns in the WTO round.

But are these concerns justified? Or is this a trick we have invented (as some believe or claim) that leads to a new form of agricultural protectionism?

The EU experience of recent years has amply demonstrated that agricultural markets are becoming more and more demand-driven.

Consumer perceptions on issues related to food safety, animal welfare or production methods undoubtedly have a direct impact on trade; but are not viewed as such by the general public. They are viewed as issues that relate to the sovereign right of citizens to choose based on their own tastes and preferences.

Thus measures that aim at incorporating these concerns into future trade agreements should not be viewed as trade impeding. On the contrary these measures are in the long run trade enhancing because they allow trade to meet these new demands, and agricultural policy to shift in order to meet these demands.

Some would claim that the adjustment of agricultural policies to meet these new concerns of society puts trade at risk, in the EU or elsewhere. Others would go as far as to claim that it is the existence of policies themselves that put trade at risk.

To them we say that we cannot and will not accept the risks involved in the absence of any agricultural policy. Let’s make no mistake about it. In such a situation, the outcome would be the development of a mostly dual production system, polarised between a partly extensive production, producing for the most affluent section of society, and a mainly intensive production, producing at lower costs to compete at world market prices.

The core of our farming system, a family-based agriculture, would be squeezed, leading to an abandonment of agriculture in the less favoured areas. The result would be less diversity in forms of agriculture and of rural communities.

Such a development does not necessarily find everyone in the European Union or elsewhere opposed to it. But it is clearly not in conformity with most CAP objectives, which have been explicitly set by EU leaders to reflect the aspirations of our society.

Thus we have opted for a different path. One that starts from the fact that our overall objectives continue to be valid but adjustments in the instruments we use in order to achieve these objectives possible.

To do this we need to advance with practical policy measures the concept of a sustainable agriculture by meeting simultaneously criteria that advance sustainability in its economic, environmental and social aspects. And we need to focus more on the relevant policy question concerning EU agriculture, which is not if, but how to support agriculture.

This implies that we constantly need to focus on our policy instruments and their implications domestically, in terms of their efficiency, distribution impacts, and budgetary implications. But also internationally, in terms of their compatibility with WTO rules, their impact on trade, as well as the impact of trade on our policy measures.

But this focus does not take place in a vacuum, but in the concrete environment of a society where agriculture is not linked to just the production of food, feed and fibre. It is also expected to contribute to such legitimate policy objectives as the preservation of the rural environment and landscape, animal welfare, or the viability of rural areas.

The challenge is to meet these objectives by policy measures that are tailored to meet specific goals in the least trade distorting way.